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January 16, 2018 

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AGGREGATE MARKET EQUILIBRIUM: The state of equilibrium that exists in the aggregate market when real aggregate expenditures are equal to real production with no imbalances to induce changes in the price level or real production. In other words, the opposing forces of aggregate demand (the buyers) and aggregate supply (the sellers) exactly offset each other. The four macroeconomic sector (household, business, government, and foreign) buyers purchase all of the real production that they seek at the existing price level and business-sector producers sell all of the real production that they have at the existing price level. The aggregate market equilibrium actually comes in two forms: (1) long-run equilibrium, in which all three aggregated markets (product, financial, and resource) are in equilibrium and (2) short-run equilibrium, in which the product and financial markets are in equilibrium, but the resource markets are not.

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INFLEXIBLE PRICES:

The proposition that some prices adjust slowly in response to market shortages or surpluses. This condition is most important for macroeconomic activity in the short run and short-run aggregate market analysis. In particular, inflexible prices (also termed rigid prices or sticky prices) are a key reason underlying the positive slope of the short-run aggregate supply curve. Prices tend to be the most inflexible in resource markets, especially labor markets, and the least inflexible in financial markets, with product markets falling between the two.
Price inflexibility prevents resource markets from eliminating shortages and surpluses and achieving equilibrium. In other words, wages do not decline even when unemployment rises. Inflexible resource prices, especially wages, help to explain the positive slope of the short-run aggregate supply curve when the price level declines. In particular, when the aggregate economy is faced with falling aggregate demand, resource employment and real production tend to fall first, bearing the brunt of the reduction, while resource prices remain relatively unchanged.

Prices, especially resource prices, tend to be inflexible for five reasons.

  • First, producers often have long-term, multi-year contracts with resource suppliers that specify resource prices. The best example is collective bargaining agreements between firms and labor unions. For most employers, as well as the labor unions, it is often easier to lay off a few workers temporarily than it is to renegotiate an agreement that contains lower wages.

  • Second, workers tend to view wages as an indication of intrinsic self-worth. If an employer should try to reduce wages, workers are inclined to view this as a personal insult. These workers might then opt for temporary unemployment, awaiting to be re-hired or seeking other jobs AT EXISTING WAGES, rather than continuing their current work at lower wages.

  • Third, the processes involved with employing and paying workers, especially such things as payroll systems, are often guided by inertia. Once wages are established (that is, entered into computer databases) explicit actions must be taken to change them. Because these actions are not costless, firms need a good reason to make changes. In other words, firms employing thousands of workers are unlikely to make small daily, weekly, or even monthly changes in wage rates.

  • Fourth, firms might actually opt to reduce employment rather than wages as a means of getting rid of the least productive workers. In other words, the firms can use a decline in sales and production as an opportunity to "clean house." Once done, the firm ends up with a workforce that is, on average, more productive and more efficient. For example, a firm with ten employees that needs to cut wage cost by 10 percent might be inclined to fire one worker, the least productive, rather than cutting wages for all ten workers.

  • Fifth, many firms, especially small ones, are price takers in resource markets. They have NO control over the resource prices set by the market. Should they find it necessary to cut wage cost, their ONLY option is to reduce employment and production.

<= INFLATIONARY GAP, KEYNESIAN MODELINFORMATION =>


Recommended Citation:

INFLEXIBLE PRICES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: January 16, 2018].


Check Out These Related Terms...

     | flexible prices | overemployment | unemployment | short-run aggregate supply curve |


Or For A Little Background...

     | short run, macroeconomics | long run, macroeconomics | price | price level | shortage | surplus | aggregate supply | short-run aggregate supply |


And For Further Study...

     | slope, short-run aggregate supply curve | full employment, long run aggregate supply | recessionary gap | inflationary gap | business cycles | Keynesian economics | monetary economics | change in aggregate supply | change in real production | aggregate supply shifts | aggregate market analysis | AS-AD model |


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